Macroeconomic instability unemployment and inflation
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Macroeconomic instability unemployment and inflation



VILNIUS GEDIMINAS TECHNICAL UNIVERSITY

BUSINESS MANAGEMENT DEPARTMENT

INTERNATIONAL STUDIES CENTER

MACROECONOMIC INSTABILITY:

UNEMPLOYMENT AND INFLATION

Made by: Vvu-2 Aleksandra Baloban

Checked by: Asoc.prof. A.Samuliavičius

Vilnius, 2004

CONTENTS

Economic cost of unemployment; groups bearing the unequal burdens 3

GNP GAP AND OKUN’S LAW 4

INFLATION AND RATE OF INFLATION 5

INTERNATIONAL COMPARISON OF INFLATION AND UNEMPLOYMENT RATE DATA 5

DEMAND-PULL INFLATION 6

COST-PUSH (SUPPLY-SIDE) INFLATION 8

TWO TYPES OF COST-PUSH INFLATION 9

REAL AND NOMINAL INCOME 9

GROUPS THAT ARE HURT AND BENEFIT FROM UNANTICIPATED INFLATION 10

POSSIBLE EFFECTS OF INFLATION ON OUTPUT AND EMPLOYMENT 10

TOPIC SUMMARY 11

TEST 12

REFERENCES 13

ECONOMIC COST OF UNEMPLOYMENT; GROUPS BEARING THE UNEQUAL BURDENS

The problems associated with measuring the unemployment rate and defining the full-employment unemployment rate do not disguise an important fact: Above-normal unemployment entails great economic and social costs.

The basic economic cost of unemployment is forgone output. When the economy fails to generate enough jobs for all who are able and willing to work, potential production of goods and services is irretrievably lost.

The are three groups that bear the unequal burdens of unemployment:

First, teenagers incur much higher unemployment that do adults. This is so because teenagers have low skill levels, more frequently discharged from jobs, and often have little geographic mobility. Many unemployed teenagers new labor-market entrants searching for their first job.

Second, the unemployment rate for blacks – both adults and teenagers – has been roughly twice that of whites. A number of explanatory factors may be at work here including discrimination in education and in the labor market, the concentration of blacks in the less-skilled occupations, and the geographic isolation of blacks in central-city areas where the growth of employment opportunities for those first entering the labor market has been minimal.

Third, male and female unemployment rates are quite comparable. The lower unemployment rate for women in the 1982 recession years reflected the fact that the male workers are dominant in such cyclically vulnerable hard-goods industries as automobiles, steel, and construction.

GNP GAP AND OKUN’S LAW

Unemployment keeps society from moving all the way to its production possibilities curve. Economists measure this sacrificed output in terms of GNP gap. This gap is the amount by which the actual GNP falls short of potential GNP. Potential GNP is determined by assuming that the natural rate of unemployment exists and projecting the economy’s “normal” growth rate. Figure 1 shows the GNP gap for recent years underscores the close correlation between the actual

Figure 1 Potebtial and actual GNP (a) and the unemployment rate (b)

unemployment rate (Figure 1-a) and the GNP gap (Figure 1-b) The higher the unemployment rate, the larger the GNP gap.

The late, well-known macroeconomist A.Okun quantified the relationship between the unemployment rate and the GNP gap. This relationship, known as Okun’s law, indicates that for every 1 percent that the actual unemployment rate exceeds the natural rate, there is generated 2 percent GNP gap. This 1:2 , or 2:5, unemployment rate – GNP gap link permits one to calculate the absolute loss of output associated with any unemployment rate.

INFLATION AND RATE OF INFLATION

Now let us tern to inflation as an aspect of macroeconomic instability. The problem posed by inflation are more subtle than those of unemployment and hence are somewhat more difficult to grasp.

What is inflation? Inflation is a rising general level of prices. This does not mean, that all prices are necessarily rising. Even during periods of rather rapid inflation, some specific prices may be relatively constant and others actually falling.

Indeed, as we shall see momentarily, one of the major sore spots of inflation lies in the fact that prices tend to rise very unevenly. Some spring upward; others ascend at more leisurely pace; others do not rise at all.

Inflation is measured by price index numbers. Recall that a price index measures the general level of prices in reference to a base period.

The rate of inflation can be calculated for any given year by subtracting last year’s price index from this year’s index, dividing that difference by last year’s index, and multiplying by 100 to express it as a percentage.

Rate of this year’s index – last year’s price index

Inflation = last year’s inde * 100%

INTERNATIONAL COMPARISON OF INFLATION AND UNEMPLOYMENT RATE DATA

Table 1 presents average unemployment and inflation rates for a five-year period in nine countries.

We see that unemployment rates vary greatly among nations of the world over specific period. The major reasons for these differences is that nations have different natural rates of unemployment and also may find themselves in different phases of their business cycles. Column 2 of Table 1 lists
average unemployment rates approximating U.S. measurement concept for nine industrialized nations for recent five-year period. Historically, the United States has had higher unemployment rates than most industrially advanced nations. But this general pattern changed beginning in the mid-1980s. As indicated in column 2, the average annual unemployment rate in the United States over the 1983-1987 period was lower than the unemployment rates of Canada, Australia, France, and the United Kingdom.

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